Dont Believe the Real Estate Hype

The Federal Reserve's pause in its rate hiking campaign has dovetailed with
the decline in energy prices and interest rates sending the Dow Jones to record
territory. It is now universally accepted by the market that the slowdown in
housing and the economy will result in a soft landing, one that keeps the Fed
on hold and G.D.P. at trend growth or slightly below. These market cheerleaders
have embraced this perfect scenario and the recidivism to their behavior prior
to the equity collapse of 2000 may be to the downfall of investors. What is
being overlooked by most pundits is that the unraveling of the housing bubble
will be much longer lasting and more damaging to the consumer than anticipated.

During 2007, approximately $1trillion of the $9 trillion in outstanding mortgages
will reset. The increase in these adjustable rates will send consumers' monthly
payments hundreds of dollars higher and cause many more foreclosure homes to
enter into this already saturated market. According to the Indymac bank of
California (the 7th largest mortgage originator in the nation), up to 4% of
home owners might lose their home in the next few months. That's four times
the average rate of borrowers who normally default on their loan!

Remember the axiom that as goes the housing market, so goes the economy. One
has to look beyond home equity extraction which has reached a total of $600
billion per year. When you account for the durable goods, commodities and labor
that are supported by the housing market you begin to realize the expanse of
the spectrum related to this part of the economy. What is difficult to factor
into the equation is consumer's response to flat or declining home values.
It is reasonable to assume that their current negative savings rate (it was
negative for only two other years 1932-1933) will again turn positive as consumption
declines.

A key point that must be stressed again is that home builders are still expanding
supply well beyond the intrinsic demand. Home construction is running at 1.7
million units while actual demand is about 1.15 million units. This could add
another .55 million units to an already near record 4 million unsold homes.
In order for the market to achieve balance, home construction must drop below
population growth and price to income ratios must fall. Neither of those situations
is occurring. Sellers have been trying to avoid lowering their asking prices;
this has kept year-over-year declines muted and hence caused prognosticators
to claim the bottom as been reached and the worst is over for real estate.

Through real estate, many banks are exceeding federal guidelines regarding
concentrated loan exposure. According to Fed Reserve data, ten states have
over 50% of total banks in violation of guidelines for real estate loans, meaning
the dangers of a banking debacle similar to the S&L crisis are elevated.
New Jersey-based home builder Kara Homes, for example, filed for chapter 11
bankruptcy protection after defaulting on nearly $300 million in debt. But
the stock market is too busy rejoicing over better than expected pro-forma
earnings reports to worry about financial disruptions like bank failures or
home builder bankruptcies.

What appears evident is that the economy is slowly weakening due to housing
and the decrease in money supply and credit (inflation). Since the Fed mistakenly
measures inflation as growth, we can predict that G.D.P. rates will be declining
for at least the next two quarters. And the equity markets are not pricing
in the shortfall in earnings which should accompany the slowing economy. Keep
an eye out for an unusually weak Durable goods number on Thursday or G.D.P.
number on Friday; any crack in the soft landing mantra would prove damaging
for stocks, especially after this huge rally. This leads me to present the
best play in the market today: invest in the stocks of balloon companies --
you know, the ones you tie "For Sale" signs onto.

With more than 16 years of industry experience, Michael Pento acts as chief
economist for Delta Global Advisors and is a contributing writer for GreenFaucet.com.
He is a well-established specialist in the Austrian School of economic theory
and a regular guest on CNBC and other national media outlets. Mr. Pento has
worked on the floor of the N.Y.S.E. as well as serving as vice president of
investments for GunnAllen Financial immediately prior to joining Delta Global.